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Health care stocks including pharmaceutical giant Merck (NYSE:MRK) have gone on a nice run of late. Merk stock has gained over 20% just since early April, touching an all-time high this week. Q1 earnings that month seemed mixed, but the market...

Merck & Co. (NYSE:MRK) is one of the largest pharmaceutical companies in the world, producing a wide assortment of medications. The company bought Schering-Plough (SGP) in 2009 to become one of the three largest pharmaceutical companies.

Merck faces many of the challenges that face all pharmaceutical companies, including issues surrounding patent expiration and FDA approval. In addition, there is growing pressure in the US and abroad to lower the price of medication. [1]

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Business Segments

For the fiscal year 2010, ended December 2010, Merck reported a total revenue of $45.99B and net earnings of $982M.[2]

Significant research and money-making drugs are related to long-term ailments such as cardiac disease, osteoporosis, and asthma. The company's segments are divided by therapeutic area, with the largest segments listed below.

This is the company's strongest segment with more drugs and nearly double the revenue of any other segment. This segment's blockbuster drugs (more than $1B in international sales) include: "'Singular"' for asthma, "'Remicade"' for inflammatory diseases, and "'Nasonex"' for the treatment of nasal allergies.

Cardiovascular (10% of 2010 Revenues)

The cardiovascular blockbuster drugs are: "'Zetia"', a cholesterol absorption inhibitor; and "'Vytorin"', a combination of Zetia and Zocor.

Diabetes and Obesity (7% of 2010 Revenues)

This segment's blockbuster drug is Januvia, a treatment for type 2 diabetes.

Diversified Brands (9% of 2010 Revenues)

The only blockbuster drug in this division is Cozaar/Hyzaar, which are used to treat hypertension.

Infectious Diseases (9% of 2010 Revenues)

The blockbuster drug in this division is Isentress for HIV treatment.

Oncology (4% of 2010 Revenues)

The main drug in this segment is Temodar used to treat certain types of brain tumors.

Vaccines (7.6% of 2010 Revenues)

The company's MMR Vaccine for mumps, measles, and rubella has blockbuster sales while Gardasil, for HPV prevention is nearly at blockbuster status.

Consumer Health Care ($1.3B in total sales for 2010)

In its acquisition of Schering-Plough, Merck inherited a $1.3 billion consumer health products division. One of the most well known brands is the Coppertone line of products, a variety of sun-block and insect repellent creams and sprays. Schering-Plough also markets the Dr. Scholl's line of foot care products, including shoe inserts, wart remover, and odor neutralizers for shoes. Consumer health care sales have remained relatively stable over the past several years; there are no major products slated to appear in the next few years, and there is no reason why demand for sunscreen would change drastically in the near future as well.

Research and Development ($11B on 2010)

Researching and developing new drugs is the single most important consideration when identifying the prospects of any pharmaceutical company. A successful drug pipeline is critical because former blockbusters losing patent protection must be constantly replaced by new viable drugs.

Trends and Forces

The main drivers in the pharmaceutical industry include product pipeline (new products in development), patent expiration (products becoming generic), and product diversification. The combination of these factors determine profits and forecasts, and are therefore very important in making investment decisions.

Merck BioVentures

BioVentures is the biologics manufacturing division of Merck established in 2008.[3] Currently, BioVentures is focused on creating generic versions of popular biologics such as Amgen's Enbrel and Roche's Avastin and Herceptin. While the generic drugs that Merck will produce in its BioVentures division will require substantial clinical trials, it is likely that the trial costs will be reduced compared to those of a novel biologic therapy. In addition, the added certainty of success -- both from a development and a market perspective -- for these follow-on drugs compared to novel biologic therapies add to the appeal of Merck's strategy.

Patent expirations

Due to Food and Drug Administration (FDA) regulations, pharmaceutical patents last 17 years, during which a pharmaceutical company has an exclusive right to manufacture a particular drug. After the patent expires, generic versions of the product can be produced and sold by competitors. Generic medication is cheaper than brand medication, and the lower cost is often a strong incentive for consumers to choose generic over brands. In addition, the presence of a generic alternative may prompt a decrease in the brand name medication price.

Tightening FDA Regulations

Beginning in 2009, the FDA implemented a series of reforms that include stricter monitoring of drug adverse events, more funding for the agency, stronger ability to force product recalls, more scientific expertise within the agency, more transparency. While the tightened regulations and increased transparency will eventually improve the overall quality of pharmaceutical products, companies will have to adjust to the stricter standards and stronger enforcement.[4]

Pharmaceuticals can face significant liabilities if a medication is later found to be defective or produce adverse reactions. Even though such adverse reactions are previously unknown and impossible to predict, damages claimed in such lawsuits are usually substantial. Depending on jurisdiction, the legal system may limit allowable damages.

For example, Vioxx was one of Merck's anti-arthritis drugs that gained widespread adoption for treating chronic pain. Up to 80 million patients were prescribed with Vioxx at its height. Soon after approval, several studies indicated that Vioxx increased the risk of heart attack over the placebo. Merck recalled the drug, but has faced several thousand lawsuits from patients who took the drug, which were eventually settled for $4.85B.

Comparison to Competitors

Major competitors to Merck include Novartis, Pfizer, and Bristol-Myers Squibb. All three are pharmaceutical powerhouses, some with compatible drugs. For example, Pfizer produces Lipitor, which is in direct competition with Zocor, and Novartis produces Diovan, which is in direct competition with Cozaar.

Competition in the pharmaceutical industry lies mostly in specific drug markets. For example, a new diabetes drug is not going to have any effect on an existing cholesterol drug, no matter how successful it is. As a result, financial data on the pharmaceutical companies do not tell the whole story. Instead, it may be more appropriate to analyze Merck's competitors by each drug market (See section on Major Drugs and Industry Trends).